The UK’s Financial Conduct Authority (FCA) has fined The Bank of New York Mellon (London Branch) (LB) and The Bank of New York Mellon International Limited (IL) £126m for breaching Principle 10 of the FCA’s Principles for Businesses (Clients’ assets), as well as rules in Chapter 6 (Custody rules) and Chapter 10 (CASS Resolution pack) of the FCA’s Client Assets Sourcebook (CASS). The Principle 10 breach lasted from 1 November 2007 until 12 August 2013. £126m is the largest fine of 2015; the 8th largest fine ever, and the largest fine of its kind (6 of the 7 largest fines were FX / LIBOR / EURIBOR related, and the 7th was in connection with the so-called “London Whale“).
LB and IL provide custody services for fund managers, pension funds, and professional and retail clients. They do this directly, and by using a network of sub-custodians, and central securities depositaries. The custody asset balances held by LB and IL during the relevant period (November 2007 to August 2013) peaked at £1.3trn and £236bn respectively.
In breach of their regulatory obligations, LB and IL:
- Failed to maintain accounts in a way that ensured that they were both accurate and corresponded to the safe custody assets they held for their clients;
- Failed to carry out regular reconciliations between their internal accounts and those of their group sub-custodians, because their internal accounts weren’t detailed enough to enable them to do so;
- Failed to carry out some asset reconciliations “on a regular basis” which, “in the context of [LB’s] operations should have been at least every six months” (!) (It’s not clear, from the FCA’s Final Notice, how “on a regular basis” came to mean “at least every six months“. It just did. OK??);
- Were unable to demonstrate (prior to July 2012) that they’d funded any un-reconciled shortfalls for which they were responsible, because they were unable to carry out adequate reconciliations, which meant that they couldn’t identify and then fund those shortfalls (if they existed) (!);
- Used some clients’ assets to settle other clients’ trades, without the consent of the relevant clients, although the Firms did not have … systems and controls that could identify the number of instances of this failure“;
- Failed properly to segregate their own assets from their clients’ custody assets;
- Failed to maintain “adequate organisational arrangements to minimise the risk of loss or diminution of clients’ safe custody assets … as a result of … misuse … fraud, poor administration, inadequate record-keeping or negligence“; and
- As a result of these reconciliation, accounting records and other failures:
- Failed to maintain adequate “CASS Resolution Packs” for a 10 month period; and
- Submitted incomplete and inaccurate Client Money and Assets Returns to the FCA.
In a sense, it’s hard to know what to make of this fine, and the reasons for it. Between them, the FCA and the two firms have undoubtedly uncovered some serious failures; and these failures could have put clients’ assets at significant risk, if the firms had entered into an insolvency procedure of some kind during the relevant period.
At the same time, the FCA’s Final Notice seems to make makes leaps of faith and logic in the pursuit of specific rule breaches that might not have occurred, but seem to have been required to justify a £126m fine. (Who would have known that “on a regular basis” meant “at least every six months“; and that a firm could be punished for failing to fund an unreconciled shortfall on an account, when there’s no evidence (albeit as a result of the firms’ own failures) that a shortfall existed and went unfunded?)
It’s also hard to escape the sense that the FCA – which has been extremely sensitive about CASS rule breaches – might be looking to punish these firms for its own historic failures.
Finally, of course, despite recent CASS rule changes – and perhaps because of them – the FCA’s CASS rules are still too often complex; difficult to interpret and apply; and expensive to honour, however much you try. This may therefore generate a sense of “there but for the grace of God go I” for many of those who will take the time to read the Final Notice…but rather more than that may be required in this case. It’s because the rules are complex, difficult to interpret and apply, and difficult and expensive to honour, that the risk of breach is higher than it might otherwise have been; and it’s because the FCA is so sensitive about these things that the risk of being caught, and the risk of receiving a very large fine, are so great. So, if you do have a sense of “there but for the grace of God go I“, pull those socks up now!